Morgan Stanley Upbeat on South African Assets Despite Headwinds

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(Bloomberg) — Morgan Stanley is positive on South African assets as headwinds from the Iran war fade, arguing that an approaching end to interest-rate hikes and further credit-rating upgrades will provide support.

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South Africa entered the second half of the year with softer growth, higher inflation and a more hawkish South African Reserve Bank after the US-Israeli attack on Iran triggered a surge in oil prices. While those developments have clouded the short-term outlook, they haven’t fundamentally altered the medium-term investment case, according to economist Andrea Masia.

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“South Africa’s growth profile looks more uneven and susceptible to downside risks in the near term,” he said in the bank’s third-quarter macro outlook. “But beyond the next quarter or two we see tailwinds from an improving supply side, lower inflation, monetary easing and faster credit extension.”

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Morgan Stanley still expects the central bank to raise rates by a quarter point at its July meeting to 7.25%, which will be the peak of the tightening cycle. However, the recent moderation in energy prices along with inflation approaching what it expects will be a peak of about 4.8% in June have strengthened the case for policymakers to pause instead, it said.

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“Our base case remains for a 25 basis-point hike,” Masia wrote. “But credible arguments for a hold have emerged.”

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The investment bank sees rates being lowered to 6.25% by the end of 2027, helping to support better financial conditions.

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Morgan Stanley’s most constructive view is of the domestic bond market.

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It expects improving public finances to help shrink South Africa’s risk premium — the richer returns that investors demand for holding the nation’s debt. The picture will be brightened by better-than-expected tax revenue generated by higher commodity prices and government debt stabilizing as a share of the economy — putting South Africa on track for additional credit-rating upgrades.

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Those factors, together with elevated inflation-adjusted interest rates, support a bullish steepening of the yield curve.

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The bank’s optimism was more restrained when it came to the rand.

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While stronger fiscal fundamentals offer medium-term support, Morgan Stanley sees persistent dollar strength, moderating precious-metal prices and uncertainty surrounding South Africa’s local government elections later this year as potential headwinds that prevent it from being more confident about the currency.

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On the economy, Morgan Stanley expects South African growth to pick up once the current energy-price shock fades, helped by lower inflation, SARB rate cuts, improving electricity supply and stronger lending. It sees the economy expanding by 1.2% this year and 1.6% in 2027.

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But that’s unlikely to lift South Africa onto a materially faster long-term growth path.

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Morgan Stanley estimates the economy’s potential growth rate remains capped at about 1.4% because investment is still too weak, limiting its willingness to become a long-term bull on corporate earnings despite an improving cyclical backdrop.

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